Partnerships key to RIL’s growth

Partnerships key to RIL’s growth

Mumbai: Reliance Industries Ltd’s (RIL) decision to acquire Bharti Enterprises Ltd’s stake in two insurance firms shows a new element of its strategy—partnerships.

Till last year, RIL had traversed a four-decade-long journey of backward integration, from being a textile producer to an explorer of oil and gas largely on its own, barring some external technical help and minor equity partners in some of its oil and gas assets. It even diversified into areas such as telecom in 2004 and retail in 2006.

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Its own endeavours helped RIL sustain an average net profit growth of 23% a year over the last decade.

As the oil-to-yarn and retail conglomerate now looks to diversify further and effectively utilize a mountain of cash on its balance sheet to create value for shareholders, it is welcoming new allies—mostly established companies in sectors and regions it wishes to enter—to learn new businesses and gain scale rapidly.

“We are gearing up for the next phase of growth through a combination of our own initiatives and forging new partnerships with leading companies," RIL chairman Mukesh Ambani said in his letter to shareholders, which forms a part of the company’s 2010-11 annual report.

On Friday, RIL announced a deal to replace Bharti with itself in two insurance joint ventures—by acquiring the latter’s 74% stake in each for an undisclosed sum—with France’s AXA Group.

The company’s statement on Friday made it amply clear that while RIL may be the majority stakeholder, AXA will continue to be responsible for the operations of the life and general insurance companies.

The rationale behind RIL’s investment, according to analysts, may be to learn the business while it is grown by AXA with the help of RIL’s capital and utilize its widespread network to market its offerings.

RIL is also not averse to offering its French partner an equal stake in the company when regulations governing foreign direct investment in the insurance sector allow so, according to the company release on the acquisition deal. Under current norms, foreign insurance firms cannot hold more than 26% stake in an insurance venture.

Second fiddle

This is RIL’s second announced venture in financial services. Interestingly, it will play second fiddle to a foreign partner in the other business as well.

In March, RIL formed an equal joint venture with DE Shaw and Co. LP, a US-based investment and technology development firm, which is the world’s largest hedge fund manager.

In a subsequent interview in May, Louis Salkind, managing director and executive committee member of DE Shaw, said the joint venture would offer a range of financial services such as private equity investments and institutional broking, among others. He also stated that DE Shaw would be responsible for running the day-to-day operations of the venture.

Which is also the reason for RIL not finding mention in the brand name of the new company—DE Shaw India Financial Services Pvt. Ltd.

Abizer Diwanji, head of financial services in India at audit and consulting firm KPMG, stated that RIL needed partners such as AXA and DE Shaw since they will bring the “skill set and mindset" required to offer financial services, which are different from those required in RIL’s core businesses such as oil, gas and petrochemicals.

Apart from providing capital, RIL’s domestic network could help the financial services joint ventures tap potential customers in the form of vendors and buyers of their products, who are always in need of funding for trading in goods.

“RIL will understand their vendors and their business better than anyone else and partners like DE Shaw can help price the credit appropriately," Diwanji said.

The need for new partners to grow its business could also be a function of the stage of evolution at which RIL found itself at present, analysts say.

S.P. Tulsian, a Mumbai-based independent stock market analyst, who has tracked RIL since it went public in 1977, said when Dhirubhai Ambani, RIL’s late founder, was moving back the supply chain from being a textile producer, the incremental capital each new business required was only marginally more.

Diwanji agrees that RIL may not have been keen to begin its financial services business as a start-up and opted for specialist partners in the hope of attaining scale quickly.

“The clock has changed and so has the strategy," Tulsian said. “The company has to deploy the huge cash on its balance sheet and create scale in new businesses quickly."

RIL ended fiscal 2011 with cash and cash equivalents of 42,393 crore.

According to a 22 February report by HSBC Securities and Markets, RIL is estimated to generate $22 billion (Rs 99,000 crore today) in cash by fiscal 2012.

Analysts have pointed out that deployment of this cash in new businesses to fetch decent rates of return would be a challenge before the company.

RIL ended Monday’s trade at 926.65 per share, down 1.84% on the Bombay Stock Exchange (BSE). The exchange’s benchmark index, Sensex, lost 0.01%.

Over the last one year, the company’s stock has underperformed the broader market. While RIL lost 11.43% on BSE over the last year, the Sensex, has gained 7.04%.

RIL’s strategy with DE Shaw also entails utilizing the former’s recently acquired telecom business as a platform to offer financial services, using technology developed by its American partner.

In June 2010, RIL acquired Infotel Broadband Services Pvt. Ltd—the sole winner of high-speed wireless spectrum across India—for 4,800 crore with a view to rolling out broadband wireless services to Indian consumers.

Asset-light approach

There, too, RIL plans to adopt an “asset-light" approach by forming strategic partnerships, Ambani had said while announcing the acquisition.

RIL will look for network and content partners to give shape to its telecom plans. Though the names of various potential partners for the company’s broadband business have done the rounds, RIL hasn’t officially named any partner.

Tulsian said Ambani’s game plan while scouting for partner companies for its various businesses such as broadband might be to create management bandwidth for them, without diverting focus from the core business that deals with energy and materials.

Ambani, a chemical engineer himself, has put in place a team to look after the conglomerate’s existing businesses.

Members of this team may not yield the same result while handling these businesses as compared with dedicated professional sourced from partners.

RIL’s entry into sectors such as telecom and financial services and the subsequent need for partners follows the termination of a non-compete pact with younger brother Anil Ambani’s Reliance Group in May last year. The pact barred the brothers from entering each others’ areas of business.

The elder Ambani’s strategy of growing new businesses is a marked contrast to that of the Reliance Group.

Anil Ambani chose to build businesses such as Reliance Communications Ltd (R-Com), the mobile telephony firm, and Reliance Capital Ltd (R-Cap) without any external help over the last five years and encountered various teething troubles in the process.

It is only now that the younger Ambani is looking for a strategic investor in R-Com, saddled with a debt of 32,048 crore, and a suitor for the firm’s telecom tower business before that.

R-Cap also announced a major deal this fiscal with Japanese life insurer Nippon Life Insurance Co. picking up a 26% stake in the Indian company’s life insurance business for 3,062 crore.

Apart from its new businesses, RIL also feels the need for fostering alliances in its core businesses as well, perhaps for the first time.

The reasons for parting with a share of profit from businesses that it has so laboriously built over the years range from exploring new markets beyond Indian shores to securing technical expertise to overcome pressing challenges.

Between April and August in 2010, RIL acquired stakes in three shale gas assets in the US for an aggregate consideration of around $3.44 billion.

In all three ventures, RIL will remain a passive investor while the local partner serves as the operator.

Shale gas refers to the natural gas trapped in sedimentary rocks.

Alok Deshpande, oil and gas sector analyst at Elara Securities (India) Pvt. Ltd, the Indian arm of a UK-based brokerage, stated that RIL may be content to play second fiddle to its American partners at present as it was in the process of learning a new technology and the US companies would have a better knowledge of the local market.

On the other hand, the $7.2 billion deal with BP Plc, the London-based oil and gas company, which saw RIL offload a 30% stake in 23 oil and gas blocks operated by it, was to secure the technical knowhow critically needed to secure the future of gas production from India’s largest gas find, being developed by the latter.

Gas production from the D6 block in the Krishna-Godavari basin has stagnated at around 51-52 million standard cubic metre per day (mscmd), as against a targeted production of 60 mscmd.

Ambani emphasized at RIL’s annual general meeting in early June that the company will work together with BP to comprehend the character and behaviour of the reservoir, and take remedial measures.

At the 2009-10 annual meeting of shareholders, RIL’s chairman had stated it would look to double the enterprise value of $80 billion (market capitalization plus net debt) attained by the company in three decades in less than 10 years.

The reasons may be diverse, but new businesses and new partnerships are surely the key to the conglomerate’s next phase of growth.

Graphic by Pradeep Gaur/Mint